While equity markets continue to defy the odds and set new records, plenty of stocks are down in 2017. What gives? Why is this happening despite the S&P 500, Nasdaq and Dow Jones Industrial Average making new record highs? This goes to show the impact a handful of stocks can have in both good and bad markets.
As of mid April, the market capitalization of Apple, Amazon, Google (Alphabet) and Facebook swelled to nearly 1/3 of the Nasdaq 100 index. Four stocks made up nearly 33% of a 100 stock index. Even further, as of May 24th, Apple, Facebook and Amazon account for 33% of the gains this year in the S&P 500! We don’t know if this trend will continue but investors should brace themselves for increased volatility. Oftentimes when a small number of stocks represent such a large percentage of an index it can lead to increased volatility as those few stocks fluctuate in value.
There are many skeptics of this rally who think that a few stocks doing a majority of the heavy lifting is not sustainable. While skepticism is understandable, history paints somewhat of a different picture. Bloomberg points out, from 1994 to 2014 the top 10 stocks in the S&P 500 accounted for nearly 50% of the gains each year!
When evaluating the “health” of a market I tend to focus on things like market breadth, which compares the number of advancing verse declining stocks. I believe this paints a more accurate picture on the health of a market as it factors in the good and the bad. An increase in the advance-decline line tends to illustrate a healthier broad and a sustainable rally and vice versa. It goes without saying that this is just one indicator and should not be used as a sole basis for making an investment decision.